Aramco clouds Saudi’s coming-out party

Saudi Crown Prince Mohammad bin Salman's goal to diversify Saudi Arabia's oil-based economy and transform the kingdom into a tech and logistics hub could ultimately be an opportunity for American enterprise.

It's a big week for Saudi Arabia's Crown Prince Mohammed bin Salman. For the first time since his elevation as heir to the kingdom, he will play host to a Davos-like gathering of the global investing elite. Heavyweights from SoftBank's Masayoshi Son to U.S. Treasury Secretary Steven Mnuchin are rolling into Riyadh to see at first hand his plans to make the city a regional financial powerhouse. Hanging over the affairs will be the up-in-the-air status of the biggest deal in capital-markets history.

Since the so-called Future Investment Initiative came together a few months ago under the auspices of Saudi's massive Public Investment Fund, questions about the viability of a planned $100 billion initial public offering of stock in Saudi Aramco, the national oil company, have intensified. Chief among them is the difficulty of reaching the $2 trillion valuation for the group that the ruling family wants, according to news stories. Last week Reuters reported that China offered to buy 5 percent of Aramco in a deal that could circumvent an IPO.

The snag with the Chinese option is that Saudi Arabia has other objectives beyond raising cash to fatten the kingdom's finances and fund social welfare. The Aramco offering is a key step towards making Riyadh a regional, if not international, capital for capital. It is part of the crown prince's blueprint for reducing Saudi Arabia's reliance on oil – a feat never fully achieved by a major resource economy in the modern era.

As noted in a report by State Street Global Advisors on the eve of the FII confab, which kicks off on Tuesday, "the Saudi Aramco transaction should be leveraged in a much more significant way to change the relationship between the Saudi kingdom, the stewards of the economy, its citizens and the international investment community."

The crown prince is banking on Riyadh's appeal as a financial hub to meet the extraordinary ambitions of his Vision 2030 plan to move away from hydrocarbons – wise given the accelerating adoption of electric vehicles – towards other industries, including financial services. Transforming the $700 billion economy and better sharing the wealth with 33 million subjects, two-thirds of whom are under the age of 30, is of existential importance for the Saudi monarchy.

Market authorities have taken strides to make the Tadawul, the Saudi bourse, an easier place for foreigners to buy shares and even short them. As a result, Saudi stocks are being considered for inclusion in indexes widely followed by investment professionals. The FTSE Russell is mulling whether to upgrade Saudi Arabia to emerging-market status. So is MSCI, which will decide by next June whether to include Saudi shares in its MSCI Emerging Markets Index. If it does, the country's weighting, at around 2.4 percent according to State Street, could lead to inflows of around $38 billion.

But the big numbers are those associated with privatizations, with Aramco top of the list. Speaking to Reuters, Vice Minister for Economy and Planning Mohammed al-Tuwaijri estimated there could be $200 billion forthcoming from the sale of various assets ranging from housing and water to telecommunications and even religious-tourism services.

Beyond bringing in foreign direct investment, selling shares to the Saudi public could tighten the monarchy's grip on the hearts, minds and wallets of its people. As State Street observes in its paper, such deals could involve a "National Privatization Fund", which like a mutual fund could be offered to citizens at a discount, minimizing "public controversies over the sale of public assets". In effect it might foster a sense of inclusive capitalism, neutralizing criticism of the royal family's excesses, like the $500 million Italian yacht the crown prince acquired, according to news reports.

Other innovations could include increased transparency about the ownership of assets that are, effectively, the state's patrimony. If Aramco incorporates good governance into its bylaws that, too, could help nurture an ownership culture among Saudis and reduce any mistrust of the ruling family. From this could follow other benefits, like the creation of a fixed-income market, albeit one compliant with sharia standards on lending and usury. That in turn would let banks off the hook for much of the risk while channeling capital to small and medium-sized enterprises, and away from state juggernauts.

The FII kicks off with a welcome from the crown prince followed by a panel that includes Aramco Chief Executive Amir Nasser. They need to sound convincing that the IPO of the biggest company ever to go public is on track. If the sale of the oil group is delayed or diverted, it would make the rest of Saudi's Vision 2030 look increasingly cloudy, too.

Commentary by Rob Cox, global editor at Breakingviews. Follow him on Twitter@rob1cox.

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